Friday, May 4, 2012

A few thoughts on inequality and redistribution

The topic of economic inequality has become prominent in popular dialogue in recent months. This is a pretty difficult issue. I don't have any big conclusions about it, but I do have a few scattered thoughts which are specific to the often implicit demand for increased wealth redistribution as a necessary and effective response to inequality. Some of these can be thought of as questions that the pro-redistribution crowd needs to answer before we become too committed to contra-inequality policies. If you don't want to read the whole post, skip to point #5.

Figure 1: Median Income by Quintile (and Top 5 Percent), 1967-2008, all races
Click for larger imageSource (H-3 All Races)

Measurement: The situation is somewhat more nuanced than most of the popular accounts have suggested. In particular, there is evidence that consumption inequality is less pronounced than income or wealth inequality, and there are good reasons to think that consumption matters more than income or wealth (some people have criticized the study on which that link is based, but the criticism is that it understates consumption of the affluent--not that it overstates consumption of the poor). To be sure, the evidence is mixed--but it's not immediately obvious that income-based measures of inequality are the appropriate way to motivate policy. In particular, any study which does not account for existing taxes and transfers should be immediately discarded for use in the debate over redistribution (though such studies may be useful for thinking about other contra-inequality policies). Further, wage data do not capture things like improvements in working conditions, which constitute an unmeasured increase in real compensation. And even our continued difficulties accurately measuring inflation have consequences for the inequality data.

Fad-based policy: This topic comes and goes in public consciousness; but research into the causes and consequences of inequality, and appropriate policy responses (including redistributionary), has been going on for years in both macroeconomics and microeconomics. But the public dialogue is more sporadic, giving emphasis to inequality when some event draws our attention to it (like recession). It's important that we make long-term policies based on long-term problems, not public reaction to a cycle of attention to this or that topic. If we want to make good policy in this area, we should consult the literature rather than drawing conclusions based on someone's blog (yeah, I know).

Cyclical vs. secular policy: A related reason for policy caution is our current position in the business cycle (the cycle of recession and growth). Recession-induced conditions will not be with us forever. Further, the recession and long road out of it seem to be causing a lot of people to forget all the economic growth of the last several centuries. Even in the depths of recession, majority of Americans were better off than they were even 15 years earlier. Excessive focus on the down side of the cycle is myopic. The consequences of cyclical economic activity should be treated with countercyclical policies. Permanent policy changes should be motivated by secular trends.

Is anyone actually getting poorer? People getting poorer is very different from people getting richer at a decreasing or unequal rate. A lot of commentators seem to be suggesting that not only has the gap between rich and poor grown in recent decades, but the poor have actually gotten poorer (see, e.g., Joseph Stiglitz). This doesn't seem to be the case, even using income statistics. Look at Figure 1 above, which plots median income for all quintiles along with the top 5 percent. And there's some evidence that available data overstate the degree of stagnation for lower quintiles due to mobility (see Russ Roberts, though there is some evidence of poor mobility). Additionally, there's that pesky fact about the cost of living: the truth is that the real cost of almost everything we consume has fallen dramatically in the last few decades. A lot of people get money illusion when they think about this. Go watch this video by Steve Horwitz, and never complain about long-term increases in dollar prices again. This long-term decline in the real price of stuff means everyone's purchasing power has increased. Everyone's. The likelihood that few (if any) groups of people have actually gotten poorer is crucial to my next point (#5). In fact, in some cases, the way we generate stagnation among "poor" people is by continually redefining poverty; using quintiles to define poverty is unwise (for example, if we define "poor" to mean the bottom income quintile, then we'll never make any progress alleviating poverty because 20 percent of Americans will always be "poor"). This problem with distribution-based measures of poverty (rather than need- or consumption-based measures) leads to my main point:

From need-based to ex post distribution-based: Even supposing the Left's narrative about inequality and what caused it is completely accurate, the data themselves do not imply any obvious policy prescriptions (particularly in regards to redistribution). We can only get policy prescriptions after we've established what we want the goal of redistribution to be. I think most people think of the goal as being need-based: we want everyone to have what they need in terms of nutrition, healthcare, and housing. We might have debates about some marginal needs, like transportation and post-secondary education. But in general, we have programs in place which meet those basic needs (food stamp programs, housing programs, medicaid, Pell grants, etc.). If those programs are failing to meet people's legitimate needs, we should fix them (but note that a change in or persistent inability of programs to meet needs is different from a continual redefinition of "need"). Regardless, that's a separate issue from economic inequality, which is completely irrelevant for need-based welfare policy. Using inequality to prompt policy responses suggests that the goal of redistribution is no longer based on need; it is based on distribution. That's a much harder goal to deal with, both in terms of justification and specification. Assuming we're meeting everyone's needs, what are the arguments for expanding our redistribution mechanisms to serve some goal regarding ex post distributions? And, supposing we're convinced that redistribution for redistribution's sake is an appropriate objective, it's still hard to articulate precise goals. It's much easier to be specific (or to at least outline key areas for debate) when our goal is need based. When it's distribution based, it's pretty hard to imagine persuasive arguments for any specific outcome metric. Are we aiming for a certain Gini coefficient? Why that number? Are we aiming for certain wealth or after-transfer income levels for each quintile? Why those numbers? And on the resource side, are we looking for some "fair share" measure of tax burden? In 2009, the top 1 percent of taxpayers earned 17 percent of US income and accounted for 37 percent of federal tax receipts (source). So as things now stand, a small handful of people are paying nearly half of income taxes. What is it about that number that is not "fair," and what number would be fair? I'm not saying the current level is too high--or too low. I'm just asking for someone to define "fair" in context and justify it. When we transition from a needs-based to an ex post distribution-based welfare policy, we open up a can of worms. The whole idea seems pretty hard to justify; and if you can justify it, it's still pretty hard to imagine reasonable quantitative targets. And once you have those targets, it's hard to imagine avoiding significant unintended consequences, for example, in terms of incentives faced by those who would otherwise be upwardly mobile through the quintiles. Whatever problems exist with mobility across quintiles are not solved, and are probably made worse, if we establish ex post distribution-based goals of redistributionary policies. That's Panodra's box. And I don't mean the music website.

You can't redistribute income: Supposing we decide that more redistribution is in order, it's important that we understand the limits of what redistribution can achieve. Taking money out of Warren Buffett's savings account and handing it to poor people affects the poor person in more ways than one. The first-order effect is more money in their pocket. The second-order effects depend on the opportunity cost of that policy. Savings always equals investment. At the extreme end, the capital in Warren's savings account might have funded a new factory where the poor person would have gotten a job; this means handing that guy money now is like killing the golden goose to get the eggs. So the amount of income accruing to the rich which can be productively redistributed (meaning, it can serve the purposes we're claiming it will serve) is not as large as some people seem to think. As Scott Sumner says, "The income statistics simply don't mean what progressives think they mean--something like 'resources available for redistribution'. . . . If you combine wage and capital income in the same aggregate, you are counting the same resources twice." Read that whole post. The lowest-cost way to redistribute is to take the cash Buffett was going to spend on consumption of private yachts. The highest cost way is to take the cash which would have been saved (and therefore invested in production of something)--or to take the cash which Buffett would have given to the Gates Foundation. But that high-cost way tends to be the easiest from a policy perspective. I am inclined to think that redistribution is going to be a really inefficient way to address the inequality problem (perhaps a better avenue is proving and addressing Mark Thoma's marginal product argument).

Some context: By both international and historical standards, most of the poorest Americans are wealthy. Our discussion of the gap between rich and poor in America is really just a discussion about the gap between the rich and the very rich (to a person in true poverty, our debate might sound like this). Whatever moral justification exists for intranational redistribution must apply to international redistribution as well. That is, to be morally consistent in our crusade against inequality, we would probably need to take every American's stuff--including the poorest Americans--and give it to someone in sub-Saharan Africa (of course, that's not a sustainable policy, but neither is ex post distribution-based intranational redistribution policy). (I know that there may be arguments for fighting inequality which don't rely on moral imperatives--I'm not talking about those). Our tacit acceptance of international inequality damages the justifications for focusing on intranational inequality. I long ago abandoned the delusion that I have the intellectual and philosophical firepower to sort through the issue of international inequality, but it's clear that intranational inequality simply pales in comparison.

These aren't dogmatic, ideological reactions to the debate. These are requests for better arguments. The people going broken-record on the inequality data aren't being forced to explain what their goal is. If their goal is a transition from need-based to distribution-based policy, they need to explain how they justify that--and they need to tell us what their target is so we can start discussing the consequences of the idea. It's hard to take the complaints very seriously when the complainers can't provide a solid justification for the connection between the data and their vaguely defined policy preferences, can't provide specific targets and policy mechanisms, can't justify those targets, and can't work through their ideas to see unintended consequences. In absence of that intellectual and conceptual framework, it's very easy for conservatives to write off the inequality debate as envy politics. Until we have this conversation and do some analysis, we shouldn't be blindly demanding this and that policy with uncertain connections to the supposed problems we think we want to solve.

I'm not suggesting that poverty and stagnant mobility in America aren't serious issues deserving of policy attention; but it's important that we avoid the Yes Minister trap: something must be done, this (more wealth transfers) is something, therefore this must be done.